Religious and Family Member FICA and FUTA Exceptions Extended to Disregarded Entities

The IRS on October 31 issued temporary and proposed
regulations that extend the religious and family member FICA
and FUTA tax exceptions to disregarded entities (T.D. 9554;
REG-136565-09). The regulations also clarify the rule that
owners of disregarded entities—except for qualified
subchapter S subsidiaries (QSubs)—are responsible for backup
withholding and information reporting under Sec. 3406.

Before 2009, the owner of a disregarded entity was
treated as the employer for employment tax purposes.
However, starting in 2009, a disregarded entity was
treated as a separate entity for purposes of employment
taxes and related information-reporting requirements;
under this rule, the entity is treated as the employer of
any individual performing services for the
entity.

Family Member
Exceptions

For FICA and FUTA tax purposes, certain
services are explicitly excepted from the definition of
employment. For FICA purposes, these exceptions include:

Services of a child under the age of 18
performed in the employ of the child’s mother or father;
and

Services performed by an individual
under the age of 21 employed by his or her father or
mother or performed by an individual employed by his or
her spouse or son or daughter (subject to certain
conditions) for domestic service in the employer’s private
home.

For FUTA purposes, the exceptions
include:

Services performed by an individual
in the employ of his or her son, daughter, or spouse; and

Services performed by a child under the age of
21 in the employ of his or her father or mother.

The treatment of disregarded entities as the employer
has meant that services a family member performed for a
disregarded entity wholly owned by another family member
could not qualify for these FICA and FUTA exceptions. The
temporary and proposed regulations fix this problem by
stating that a disregarded entity will not be treated as a
separate entity for purposes of these FICA and FUTA family
member exceptions.

Religious Employee
Exception

Sec. 3127 provides an exception from FICA
tax where both the employer and employee are members of a
religious faith that opposes participation in Social
Security. The treatment of disregarded entities as the
employer has also meant that services performed by a member
of a qualifying religious sect for a disregarded entity
wholly owned by another member of the qualifying religious
sect could not qualify for the exception because, as a
corporation, the entity cannot be considered a member of a
qualifying religious sect.

The temporary and proposed
regulations state that a disregarded entity will not be
treated as a separate entity for purposes of applying the
religious employee exception of Sec. 3127.

Backup Withholding and Information
Reporting

When the change was made in 2009 to treat
disregarded entities as separate entities for purposes of
employment taxes and related information-reporting
requirements, the regulations did not explicitly state that
a disregarded entity is not responsible for backup
withholding and information reporting under Sec. 3406 (the
owner remains the responsible person). Therefore, the
temporary and proposed regulations clarify that disregarded
entities are not responsible for backup withholding and
information reporting of reportable payments under Sec. 3406
(except in the case of QSubs, which are treated as separate
corporations for employment tax purposes under a separate
regulation (Regs. Sec. 1.1361-4(a)(7)).

The temporary regulations apply with respect to wages
paid on or after November 1, 2011; however, taxpayers may
apply the new rules to wages paid after January 1,
2009.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.